What Happens to the Inner Circle of the Ousted CEO?

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It’s a situation that fortunately doesn’t come up very often, but when it does, board members and/or the new CEO face a huge dilemma: How should they deal with the inner circle of an ousted CEO – those top executives who presumably supported, or at the very least were aware of, the actions and initiatives of their former boss?

The question becomes more urgent if the ousted CEO engaged in criminal behavior related to his or her role at the company.

Tyco International – and the resignation of chief executive L. Dennis Kozlowski on June 3, shortly before he would have been removed by the board – is only one of the most recent very public examples. Some others that have made headlines include the ousters of Joseph P. Nacchio at Qwest Communications International on June 16, 2002, Bernard Ebbers at WorldCom in April 2002, Jacques Nasser at Ford in October 2001, Richard McGinn at Lucent in October 2000, Rick Thoman at Xerox in May 2000 and Eckhard Pfeiffer at Compaq Computer in April 1999.

The state of affairs at Tyco is especially tricky, according to press reports, because Kozlowski’s closest associate, CFO Mark Swartz, is said to have been an integral part of the CEO’s now-maligned acquisitions strategy for the company. The question has also been raised as to what Swartz may have known about alleged criminal behavior on Kozlowski’s part regarding sales tax evasion and use of company funds for personal expenses.

At the same time, Swartz, according to a recent article in the New York Times, is highly regarded on Wall Street and is considered one of the few Tyco executives who understands the intricacies of Tyco’s business strategy. So far, as the Times notes, the Tyco board has left Swartz in place but appointed a former Tyco board member, rather than Swartz, as interim chief executive.

Michael Useem, director of Wharton’s Center for Leadership and Change Management, predicts that Swartz “may be forced out. While he was one of the masterminds behind the company’s many mergers, and knows the intimate details of how the company operates, he was also Kozlowsky’s right-hand guy. He may be ushered to the exit if the board and prosecutors press Tyco to clean house.” Useem’s first book on business management, written in 1984, was entitled The Inner Circle.

One consideration in this issue is whether, after a CEO is ousted, “the board of directors is capable of looking, independent of the circumstances, at the executives who are still there, or whether they end up being tarred with the same brush,” says Robert Mittelstaedt, vice dean and director of Wharton’s Aresty Institute of Executive Education. “Any board that is smart won’t end up throwing away talent unnecessarily.”

The problem in Tyco’s case, however, “is that as you begin to peel back the onion you realize this could be a lot more complex than originally thought,” Mittelstaedt added. “You assume that some people, like the legal counsel, had to have known what was going on.” Indeed, last week Tyco’s board fired its general counsel, Mark Belnick, amid accusations that he was impeding an internal investigation into possible fraudulent actions by company insiders, including himself. Belnick denies the charges.

The role a CEO’s inner circle plays in the company “is crucial in deciding whether they stay or not, and the way to decide is to look at whether the people have some importance to the culture of the organization going forward,” says Peter Cappelli, director of Wharton’s Center for Human Resources. “If you don’t want to get rid of them, you can, for example, move them to different roles elsewhere in the organization.”

But it’s hard to imagine, Cappelli adds, “that the executives around the CEO are not part of the CEO’s agenda. The question becomes, to what extent would executives be able to say that they were just following orders, executing a flawed policy they didn’t like … The farther down in the hierarchy you go and the more it appears that people were literally just performing functions, the less reason there is to oust them. If you start seeing a lot of people getting pushed out, like those at the director level, then it’s clearly punitive. It’s also very disruptive to the career management of the company going forward. Employees might ask themselves if they really want to be a director” in this type of company.

Ian MacMillan, director of the SolC.SniderEntrepreneurialResearchCenter, describes a familiar scenario where an ousted CEO has “inhibited the ability of [talented] executives to be effective. There the challenge for the new management is to make these people feel whole, as it were, and not feel that they were part of the gross incompetence” that led to the previous CEO’s removal. “You want to make sure you preserve the integrity of the organization by keeping the very best people,” MacMillan says.

One would hope, from a corporate governance perspective, adds Mittelstaedt, that the CEO has brought in people who are good enough that their performance and future are independent of the CEO’s. Yet most people immediately assume that the people who are the CEO’s direct reports are so loyal to him or her that they can’t be allowed to stay on. That could be a wrong assumption.”

Hitting the Brakes at Ford

When Jacques Nasser was fired as CEO of Ford in October 2001 – after a run of less than three years – some members of his management team were fired also, including the vice president of human resources, says management professor John Paul MacDuffie, co-director of Wharton’s Reginald H. Jones Center for Management Policy, Strategy, and Organization, and an authority on the auto industry. Those whose “management styles were closest to Nasser’s were kicked out while those who weren’t so closely affiliated with Nasser were most likely to be kept. That sends a good signal … The message was that the decisions were based on an assessment of what was needed to turn the company around.”

In Ford’s case, it wasn’t just a question of replacing Nasser with William Ford, grandson of the company founder. It was also a case of putting the brakes on many of Nasser’s initiatives to expand the company and instead return to a more back-to-basics approach.

Indeed, a number of Nasser’s team, many of whom he had recruited from outside the industry, were replaced with others who had Ford affiliations. For example, Allan Gilmour, who had resigned more than five years ago from the company, was appointed vice chairman and CFO in May. He replaced Martin Inglis, who, although reportedly close to Nasser, remains with the company as group vice president for global business strategy.

In July of 2001, Ford had named Nick Scheele, then head of Ford of Europe, as group vice president of North America. Following Nasser’s departure in October, Scheele then became COO (his title now is president, COO and director) and he has since been assembling his own management team. Scheele “was not part of a completely new regime, but he was different from the old regime. In a sense, the company bridged” the transition with his appointment, MacDuffie says.

The most effective leaders after a crisis, he adds, “are ones who provide a vision that can be unifying for people wherever they were before the crisis occurred. If you pick the right kind of person, he or she should be able to overcome the obvious turmoil.” Nasser had a reputation for arrogance, for “not being a very good listener … He had a domineering kind of presence, and nobody would give him bad news or contradict him. He had a million new things he wanted to do and everybody kept saying yes to him.”

Bill Ford, MacDuffie says, has done a good job “evoking some of the spirit of the company that has made it so strong historically, but you have to worry whether they have swung too heavily from the innovative risk-taking spectrum to much more of a conservative approach. Even if this approach is right in the near term, surely several of the initiatives undertaken by Nasser are going to be relevant and important at some future time.”

The Inside Game

While both Tyco and Ford offer examples of ousted CEOs who had built up a management team during their company tenures, Xerox is a different story, says Useem. CEO Rick Thoman had been hired as president of the ailing copier in 1997 – and given the title of CEO in 1999. He set about attempting to convert the company from an old-line, old economy business to one that could meet the requirements of 21st century offices.

In May 2000 Thoman was ousted by Paul Allaire, Xerox’s former CEO and at that time its current chairman, who, according to a Business Week cover story in March 2001, told Thoman that the board no longer had confidence in his ability to turn around the firm. The board, Allaire said, had decided to press ahead with an internal team rather than an outsider, as Thoman clearly was. In May 2000 Anne Mulcahy, a 25-year Xerox veteran, was named president and COO. She became CEO in the summer of 2001.

According to Useem, not many people in Thoman’s inner circle were ousted with him because he didn’t really have an inner circle. “That was part of his problem,” says Useem. “Many of the people below Thoman when he came in were loyal to Paul Allaire and to his way of doing business rather than the new boss.”

Press reports of the handover of power from Thoman to Mulcahey emphasize that Mulcahey was the consummate Xerox insider and moved quickly to put together her own management team composed of other Xerox managers. Ironically, one of the ‘insiders’ that Thoman had clashed with was CFO Barry Romeril, whom Allaire had refused to allow Thoman to replace, according to Business Week. Romeril retired at the end of 2001 around the time that the SEC announced an investigation into the company’s accounting practices. New CFO Lawrence Zimmerman, who was appointed last month, retired in 1998 from IBM, the same company Thoman had worked for before coming to Xerox in 1997.

Compaq Computer offers yet another variation on the ousted CEO story. CEO Eckhard Pfeiffer was forced out of the giant computer manufacturer in 1999, eight years after taking part in a boardroom coup that had removed then-CEO Rod Canion. Although Compaq had done well during the 1990s, by the end of that decade both the company and Pfeiffer were under fire for losing market share to rival Dell Computer Corp. and being slow to take advantage of Internet opportunities. As for his inner circle, “he was a tough boss to work for,” says Useem, and “he had fewer loyalists as a result. The Compaq board could therefore reach into senior management for a replacement for him.”

As in the case of Xerox, Pfeiffer’s successor was chosen from inside the company: Michael Capellas was named president and CEO in July 1999 and chairman and CEO in September 2000. He is now president of Hewlett-Packard following the recent merger of HP and Compaq.

Cashing In His Chips

In Michael Lewis’ book, Liar’s Poker, published in 1990, the author tells of an attempt by John Gutfreund, then chairman and CEO of Salomon, Inc., to make a poker bet with one of his colleagues for $1 million. (The colleague upped the bet to $10 million and Gutfreund decided not to play.)

Useem cites this anecdote in his 1998 book, The Leadership Moment, while describing the Treasury bond scandal that engulfed Salomon – up until then one of Wall Street’s most respected investment banks – in 1991. By waiting more than three months to report illegal behavior by a Salomon bond trader, Gutfreund and his management team ultimately had to resign. The scandal almost toppled the firm.

“The disaster was so huge that the price of restoring credibility was to bring in completely new top management,” says Useem. “The result was a vast loss of institutional memory on a fateful day in August 1991 when the entire inner circle was forced out. While often necessary, firing the top team nonetheless means that you lose all those who really know what is going on.”

In the case of Salomon, the firm hired Warren Buffett, at that time Salomon’s largest stockholder, to become interim chairman and CEO. Buffett immediately asked the company’s 12 remaining senior managers who from inside the firm they thought should be designated to run the firm with him. The overwhelming choice was Deryck Maughan who was then head of Salomon’s investment banking business. He was immediately labeled “Mr. Integrity” by the press. Also joining the management team was Buffett’s personal lawyer, who became Salomon’s general counsel.

“When things go very badly, you should bring in new talent and not just replace the top person,” says Useem. “This stems from the premise that what really counts is the top management team and not any single individual.”

Stewart Friedman, director of Wharton’s Work/Life Integration program, says that “it’s all about perception.” “If key stakeholders, like board members, analysts, employees, suppliers, important customers and so forth, see that the people who are hanging around after the CEO is ousted are going to continue in that CEO’s direction, then those employees are in trouble. They should immediately create a kind of distance, a perception that they are going to play the new game. It can be hard to do that, which is unfortunate, because in some cases where [members of the CEO’s team are pushed out] the company ends up losing important assets.”

MacDuffie suggests that a CEO’s ouster is often the “result of a number of circumstances. Sometimes a person takes a job just when the company is blowing up” because of actions before that person arrived. “It may be important to hold someone accountable to the point of ousting that person, but to assume that it is wise to remove all the expertise on the team is to overstate the causality. The message is that the problems were the fault only of those leaders, when that may not be the case at all.”

According to Useem, the situation can also depend, in part, on how big the CEO’s error was. “If it was just a matter of personal error or malfeasance, it does not necessarily reflect badly on others in the inner circle. But in the case of Enron, for example, the errors and malfeasance were corporate, not just individual. That’s a wholly different circumstance, and in that instance the entire inner circle had to go.”